Participants

David Gladstone; Chairman of the Board, Chief Executive Officer; Gladstone Capital Corp

Michael Licalsi; General Counsel, Secretary; Gladstone Capital Corp

Robert Marcotte; President; Gladstone Capital Corp

Nicole Schaltenbrand; Chief Financial Officer, Treasurer; Gladstone Capital Corp

Mickey Schleien; Analyst; Ladenburg Thalmann & Co. Inc.

Robert Dodd; Analyst; Raymond James

Presentation

Operator

Greetings, and welcome to the Gladstone Capital Corporation's first-quarter earnings call. (Operator Instructions) As a reminder, this conference is being recorded.
It is now my pleasure to introduce Mr. David Gladstone, Chief Executive Officer. Thank you. You may begin.

David Gladstone

Well, thank you very much. Nice introduction. This is David Gladstone, Chairman, and this is the earnings conference call of Gladstone Capital, trading symbol, GLAD, and it's the quarter ending December 31, 2024. And I want to thank you all for calling in. We're always happy to talk to our shareholders and analysts and welcome the opportunity to provide an update for our company.
And now we'll hear from our General Counsel, Michael LiCalsi, regarding certain forward-looking statements. Michael?

Michael Licalsi

Thanks, David. Good morning, everybody. Today's report may include forward-looking statements under the Securities Act of 1933, the Securities Exchange Act of 1934, including those regarding our future performance. These forward-looking statements involve certain risks and uncertainties that are based on our current plans, which we believe to be reasonable.
The many factors may cause our actual results to be materially different from any future results expressed or implied by these forward-looking statements including all the risk factors in our Forms 10-Q, 10-K and other documents we filed with the SEC. You can find them on the Investors page of our website, www.gladstonecapital.com. You can also sign up for our e-mail notification service while you're there. You also find documents on the SEC's website at www.sec.gov.
Now we undertake no obligation to publicly update or revise any of these forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. Now today's call is an overview of our results, so we ask that you review our press release and Form 10-Q, both issued yesterday for more detailed information. Again, you can find them on the Investors page of our website.
And with that, I'll turn it over to Gladstone Capital's President, Bob Marcotte. Bob?

Robert Marcotte

Thank you, Michael. Good morning, all, and thank you for dialing in this morning. I'll cover the highlights for the quarter ended December 31 and a few of the subsequent events before concluding with some comments on our near-term outlook for the company.
Beginning with our last quarter results. Fundings were strong last quarter, totaling $152 million, including six new portfolio companies representing a combination of attractive refinancing opportunities and a pickup in the pace of lower middle-market buyout activity. As anticipated, exits and prepayments spiked to $165 million. However, since the inflows include a large equity gain on ARA of $64 million, our total debt investments actually increased by $45 million on the quarter.
Investment income for the period declined by $1.8 million to $22 million as the decline in SOFR rates accounting for the bulk of the 90 basis point reduction in the weighted average portfolio yield to 13.1%. Average earning assets also declined 2.6% with the magnitude of portfolio turnover and because of an additional investment being added to our nonearning asset list.
Interest and financing costs declined by $700,000 or 13% on lower average line borrowings and net management fees declined by $1.7 million with the surge in new deal origination fee credits, leading to an increase in net investment income of $300,000 to $11.2 million. Net realized gains came in at $58 million for the quarter and contributed to the $15.9 million of net realized and unrealized gains, which lifted our ROE to just over 22% for the quarter and the TTM period.
With respect to the portfolio, the reinvestment of the ARA proceeds lifted our senior debt holdings to 73.4% of the fair value of the portfolio and total debt holdings by 5% to 89.3% of the portfolio at fair value. During the quarter, we foreclosed on EGs, a regional QSR based in the Southwest and today are well into the operational restructuring of the business, including new management, the closing of unprofitable locations and significant overhead cost reductions. We expect to achieve the timely completion of this process, which should result in the sale of the investment or return of the investment to our performing status.
With the addition of this company to our non-earning investments, the total at the end of the quarter rose to $52.7 million at cost or $28.5 million or 4% of assets at fair value. The bulk of the $15.9 million of net appreciation for the quarter was led by our equity co-investment in Sokol Foods, which was sold to a strategic buyer shortly after the end of the quarter, and a small incremental appreciation of our position in ARA. The improved performance of several smaller manufacturing consumer and service-oriented businesses also outpaced the underperformers and we elected to exit our small underperforming position in DKI at a modest loss.
Following the end of the quarter, we exited two additional portfolio investments representing debt proceeds of $26.1 million and a $5.8 million equity proceeds from our Sokol investment. And consistent with last quarter's activity, we remained -- maintained our momentum by closing two new portfolio investments thus far this quarter, representing a total originations of $38 million.
And reflecting on our outlook for the next quarter or two, I'd like to leave with the following: we continue to expect the elevated level of portfolio exit and repayments to continue for the next one to two quarters and are very focused on the timely redeployment of these exit proceeds to maintain our investment asset base. Prepayments or closing fees are expected to remain elevated during this period of portfolio turnover and the magnitude of margin compression in the lower middle market has been more muted as evidenced by our originations last quarter, which were closed at a weighted average spread above 700 basis points over SOFR and a weighted average closing leverage of 3.4 times EBITDA.
We continue to see a healthy level of attractive lower middle market financing opportunities, typically under $10 million of EBITDA, and where low leverage or pricing dictate, we will consider teaming with commercial banks to blend down the overall cost of the financings we can deliver.
In addition to recycling some mature investments, we expect to continue to benefit from an incumbent position as the originator, lead lender and in some case, equity co-investor in the newer vintage growth-oriented businesses as they look to grow through acquisition or expansion and support the appreciation of their equity position. We ended the quarter with a conservative leverage position with debt at 70% of NAV and the bulk of our bank credit facility available to support the growth of our earning assets and shareholder distributions in the coming year.
And now I'd like to turn the call over to Nicole Schaltenbrand, the CFO of Gladstone Capital, to provide some more details on the fund's results for the quarter.

Nicole Schaltenbrand

Thanks, Bob. Good morning, everyone. During the December quarter, total interest income declined $2.1 million or 8.8% to $21.3 million as the weighted average yield on our interest-bearing portfolio declined from 14% to 13.1% with a 62 basis point decline in the average SOFR rate from last quarter. Other income rose to $600,000 and total investment income was $22 million, which was down $1.8 million or 7.4% from last quarter.
Total expenses declined $2 million quarter over quarter as net management fees decreased $1.7 million with the surge in origination fee credits. Interest expenses declined $700,000 on lower bank borrowings and other expenses increased $300,000 with several onetime deal-related expenses. Net investment income for the quarter rose 2.5% to $11.2 million or $0.50 per share. The net increase in net assets resulting from operations was $21 million or $1.21 per share for the quarter ended December 31, as impacted by the realized and unrealized valuation depreciation covered by Bob earlier.
Moving over to the balance sheet. As of December 31, total assets rose slightly to $815 million, consisting of $799 million in investments at fair value and $16 million in cash and other assets. Liabilities declined with the retained earnings -- retained equity gains to $335 million as of December 31 and consisted primarily of $254 million in senior notes and $61.5 million in advances under our line of credit.
As of December 31, net assets rose to $480 million from the prior quarter end with investment appreciation and a small amount of shared issued under our ATM program. Specifically early last quarter, we issued just under 100,000 shares, raising $2.5 million at an average price of $24.90 per share. As a result, NAV per share rose $1.21 from $21.18 to $21.51 as of December 31.
Our leverage as of December 31 declined to 70% of net assets. And after the end of the quarter, we funded two new investments, including an $18 million second lien investment in the private label food producer and a $19.4 million first lien loan to Viron International. We also received $20.7 million from the payoff of our debt investment in Fix-It and a debt repayment of $5.4 million and equity proceeds of $5.8 million from the sale of our interest in Sokol.
With respect to distribution, monthly distributions for January, February and March are $0.165 per common share, which is an annual run rate of $1.98 per share. The Board will meet in April to determine the monthly distribution to common stockholders for the following quarter. At the current distribution rate for our common stock and with the common stock price at about $28.09 per share yesterday, the distribution run rate is now producing a yield of about 7%.
And now I will turn it back to David to conclude.

David Gladstone

All right. Thank you so much. Bob, Nicole, Michael, you all did a great job of informing our stockholders and analysts that company is doing a great job and wow, what a quarter that was. In summary, just a wonderful quarter in Gladstone Capital, including team rose to the challenge of sourcing and closing on $152 million of new investments. That's a great way to start a quarter.
And we look at the underwriting and the leverage and the pricing disciplines to maintain the portfolio investment balance at almost $800 million now. Company delivered a net investment income and realized gains totaling $69 million, and that's about $3.09 per share, which is more than supporting the $895 million in regular capital gains and dividends and distributions paid out last quarter. Strong portfolio performance generated another quarter of net profitable portfolio appreciation, bringing the cumulative portfolio appreciation in the past year to $2.53 per share and lifted NAV per share by 12% compared to December 2023.
In summary, the company continues to stick with a strategy that has proven for the last 20 years to bring nice returns and dividends to our shareholders. We're investing in growth-oriented lower middle market businesses with good management. Many of these investments are supported by midsized private equity funds. This is about the same size as our funds, some of them. And they're looking for experienced partners to support the acquisition and growth of the businesses which they are investing. And this gives us an opportunity to make attractive interest-paying loans with small equity investments along the way; we call them sometimes equity kickers. And it's just a wonderful business. I've been doing that for most of my career, and Bob picked it up and has run with it and have a great team of people that we brought along with us now. So we're in a very strong position.
And now operator, if you'll come on and let's have some questions from the analysts or investors in our company.

Question and Answer Session

Operator

(Operator Instructions) Mickey Schleien, Ladenburg Thalmann.

Mickey Schleien

Yes. Good morning, everyone. Bob, many BDCs avoid investing in restaurants because they're very difficult to underwrite. But you've had success there recently with Salt & Straw with the Salt & Straw exit, and now you've invested in Wings 'N More. Could you tell us what attracts you to this sector and what do you look for in a restaurant deal before you invest?

Robert Marcotte

Good question. Good morning, Mickey. The bar is very high on restaurants. Typically, what we're looking for is a compelling business model that has a margin profile, a loyal customer base, a management team that can continue to perpetuate that. And we go in with a very disciplined approach to the leverage structure that generally squeezes down leverage the moment that results or challenges arise.
We've been invested in several restaurants and are very focused on sustainable margins on a cost basis. Certainly, food and protein costs are somewhat volatile, very efficient labor models where they are cognizant of our hourly and scheduled labor burden. And lastly, restaurants that don't require massive build-out since that extends the life period to achieve a reasonable return. Most of the restaurants we're looking at are somewhere between three and four years in terms of payback.
So when we look at our restaurants, typically, we're going into those well under three turns of leverage. And in cases where, EGs, as an example, things did not work out the ability to squeeze down costs, close some locations and see a path to exiting to a strategic or through cash flow continue to exist. It's just a sector that we drill in deep and focus on those issues and have been able to manage them to reasonable overall returns.

Mickey Schleien

That's great.

Robert Marcotte

I would also add, Mickey, we're probably not going to be putting a ton more of restaurants on the portfolio. There's a point at which saturation makes some sense.

Mickey Schleien

No, I understand. Thanks for that. Bob, you're in this position with a lot of liquidity on the balance sheet and the stock trading at a very large premium to NAV. So in that situation, would you consider temporarily investing in more liquid credits to put some of this capital to work?

Robert Marcotte

Mickey, it's an interesting question. Frankly, I don't think so. And the simple reason is our marginal capitals are bank lines. Our bank lines are not cheap. And when you look at the spreads that are available on liquid credits today, I think the marginal return on equity would be very low, given the spread compression on those issues. And most of those larger liquid names, quite frankly, we can't get the primary diligence so we can't engage with the management teams or sponsors as much as we'd like. We don't get the covenant structure we're looking for, and we're basically along the ride on documents that we may not necessarily control. So I don't see us going in that direction for a variety of reasons.

Mickey Schleien

I understand. My last question is, if you could give us some insight into the outlook for Engineer Manufacturing Tech or Engineering Manufacturing Tech?

Robert Marcotte

Good question. That company is a very highly automated, attractive capital base that can produce a variety of products. It has capability and diversity of its customer base. Unfortunately, one of the larger customers last year, late in the year, decided to in-source a significant amount of revenue. It was actually the largest customer. And we have been backfilling some of that customer opportunity. I will say that there is some additional management that we're putting in place in that particular situation.
And the outlook for '25 is actually fairly strong. They've had the largest or the most significant increase in January that they've had in a number of years. Some of it's driven by data center customers that are continuing to build out looking for precision products. Others are folks that are resourcing or altering their supply chain to bring products back to the US. So we are working to retool some of the sales efforts, replace that sales exit and capitalizing on current trends in the marketplace. It's still generating a reasonable level of cash flow and supporting its debt. It's the EBITDA momentum that we're looking to rebuild given what I've described.

Mickey Schleien

I understand, and that's good to hear. Those are all my questions this morning. Thanks for your time.

David Gladstone

Do we have another question?

Operator

(Operator Instructions) Robert Dodd, Raymond James.

Robert Dodd

Hi, everybody, and congrats on the quarter and the realized gains generated. Just Bob, if I can go back to EGs, you said you're well along the way. Do you have -- and I know this is hard, right, but a rough time, I mean, how long do you think it would be before that the Capital either becomes income producing again or gets liquidated? I mean, is it six months, twelve months? I mean, do you have any view on how long that's going to be?

Robert Marcotte

I'll say six months, Mickey, but I hope it's significantly less than that.

Robert Dodd

Thank you. And then, excuse me, I mean, your activity levels are very robust. I mean, obviously, you just had a big inflows as well, but nonetheless, you're deploying a lot of capital. Where -- I believe your target leverage is about 1:1, I think, if I remember right. How long do you think you could take to get there if '25 is an active year? You're clearly finding good opportunities with good structures, et cetera. So I mean, do you think you could be at, say, 1:1 leverage at this time next year or is that unrealistic with the amount of repayment activity that might be coming in?

Robert Marcotte

I think you asked that similar question last quarter. (laughter) I would say what I told you last year last quarter was, the mission is to hold serve. I mean, $150 million on an $800 million portfolio is close to 20% turn in one quarter. I would expect that we could see a similar amount over the course of the next quarter or two. So 40% in two quarters, if we can run ahead of that, I think it's a plus. And then it just becomes a matter of whether things calm down.
I do think that continuing to string together $150 million origination quarters is well above our historical pace of probably $200 million a year. But I do think that there is a reasonable prospect in the last two quarters of the year to move the leverage up. I would say that part of that equation is, what are we looking for in terms of yield given the overall market situation. We've been very disciplined in trying to hold our overall incremental ROE on these investments.
And so, as I said, limited amount of return degradation. To manage that, there's probably two things. One, scale will help, but we also need to address our capital costs. And whether it's our bank line or whether it's the refinancing of a couple of our outstanding liabilities, those would be part of the equation to drive incremental volume in the second half of the year.
I'll remind you that we have a fairly expensive baby bond call date in September at 7.75% refinancing that to lower our cost to give us additional flexibility to take on additional assets and grow the pacing. So the answer is a multi-tiered solution, but we're not going to push it if we don't get the yields we're looking for or can't modify our cost to preserve our ROE.

Robert Dodd

Thank you. Very, very helpful. If I got one more on -- excuse me -- have you got any preliminary analysis that you've done like exposure to tariffs or on -- with (inaudible) exposure to government contracts, et cetera? I mean, how do you feel about your exposure on those fronts with things changing rather rapidly at the moment?

Robert Marcotte

It's interesting. We obviously deal in businesses that fabricate precision products, and metals are a big part of that. Most of the folks that are processing those today are going into markets that feel pretty good about, I mean, defense or aircraft engines, aerospace type products. Those are relatively insensitive markets, and certainly, the final cost of the product is relatively low from a metal perspective. The processing is a meaningful percentage. We don't really have a ton of commodity like processors. We've clearly steered clear of most of the foreign operations and foreign sourcing, given the BDC and domestic assets.
The one area that I say we probably got some exposure to is the auto market. The auto market is one where supply chains extend into Mexico. And as you probably heard in the news between metals and tariffs, there's a lot of turmoil going on. And I think the Chairman of Ford came out earlier today about what the implications might be.
We have two smaller investments in that category. We are watching them closely. They've got good solid platforms, but certainly, these changes are going to create some stress, at least in the near term. So I would say the auto market is probably the single largest area where I think we have some concern about that, but we're monitoring those situations very closely.

David Gladstone

Next question, please.

Operator

Thank you. I'm not showing any further questions at this time. So the floor is yours, Mr. Gladstone, for any closing comments.

David Gladstone

All right. Thank you all for calling in. This was a great quarter, and we continue to go forward and make dividends for our shareholders. So tune in next time, and we'll answer questions again. That's the end of this call.

Operator

Thank you. That does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.